ByEzra Fieser, CorrespondentNovember 26, 2012

SANTO DOMINGO, Dominican Republic — For a territory of just more than 56,000 people, the Cayman Islands boasts an impressive corporate roster: From some of the favorite US brands like Coca-Cola and Federal Express to the world’s richest sports franchise, English football club Manchester United.

The three-island British territory tucked just south of Cuba in the Caribbean Sea has more than 92,000 registered companies, according to the government, most of which do the majority of their business elsewhere.

A check around the Caribbean reveals similar stories. The islands have long been attractive because they collect little or no taxes. They’ve built economies around financial services, which has proven a more reliable source of income than tourism in recent years. And over time they’ve helped foreign companies and well-heeled individuals reduce their tax bills. Among them is the hedge fund Bain Capital, of Mitt Romney fame, which became a lightning rod for criticism during the presidential campaign.

But something happened on the way to tax haven status: Caribbean governments have accumulated massive debts they are struggling to repay. Without the taxes most governments use to pay for the costs of running public works projects or social programs, the bills have added up. With little in the way of economic expansion – The United Nations forecasts 1.6 percent growth this year for the Caribbean – governments are turning to other means.

“It is a well established fact [that] … any government has but one fundamental way to … have the resources available to fulfill its obligations to its citizens… and that is to raise taxes or fees,” D. Orlando Smith, minister of finance in the British Virgin Islands (BVI), said in a Nov. 15 budget presentation.

But industry analysts and tax specialists believe new fees and taxes will bring in needed money for government coffers while doing little harm to the business community.

'The need to raise revenue'

In the BVI, Mr. Smith proposed an increase in trade license fees, which businesses are required to purchase to operate there, and to base work permit fees on salary levels, meaning higher-paid workers, many coming from large companies with multimillion dollar payrolls, would pay more. His counterpart in the Cayman Islands has proposed an increase in registration fees for hedge funds. And in the Bahamas, the government is considering a sales or value added tax as well as a broad-based corporate tax for the first time.

“This is coming from the same pressure that is affecting other governments around the world: the need to raise revenue,” says Bruce Zagaris, a Washington-based lawyer who has advised Caribbean governments on tax matters. “Small countries, like those in the Caribbean, are more limited in the ability to raise revenue. In many, such as the Bahamas and Cayman Islands, there is no income tax.”

Places like St. Kitts & Nevis and Barbados are among the world’s most indebted governments, with debt-to-gross domestic product ratios of 151 percent and 118 percent, respectively, according to International Monetary Fund (IMF) data. Much-maligned Greece’s debt is only slightly higher at 161 percent, according to the European commission.

Raising taxes is never easy or popular. But taxes are generally so low or nonexistent in the Caribbean that raising them comes only in dire straits.

“In the Bahamas, we’re approaching a debt ratio of 50 percent, which is not as high as some other places in the Caribbean, but it’s too high for us,” says a high-ranking member of the Bahamas Ministry of Finance whose name was withheld because he is not authorized to speak on the record. “So we have to increase the level of tax we collect to balance it out.”

The government is considering a broad-based consumption tax on goods and services, which would directly impact locals. A corporate tax, which would impact the tens of thousands of international companies registered there, is less likely, but it is “on the table,” he says. “The IMF has always indicated to us that a broad-based corporate tax would be a remedy.”

But there is little fear that such a tax would chase away corporations.

“These amounts are so small compared to the level of money that is being made and invested,” says Andrew Schneider, president and chief executive of Global Hedge Fund Advisors, which has helped numerous hedge funds establish in the Caribbean.

Assets in the Cayman Islands total more than $1.6 trillion, while the proposed registration fees would total less than $3 million.

'low tax' vs. 'no tax'

Mr. Schneider says the hedge fund industry is expanding at a pace not seen in years, with sector growth between 20 percent and 30 percent. The growth has increased demand for banks and companies that assist funds in setting up. And they are looking to established, trustworthy tax havens, such as the Caribbean.

“I think this is a perfect time for the governments to increase fees,” Mr. Schneider says.

What’s more, some businesses are seeking out jurisdictions with low taxes, rather than no taxes at all. “When they come under scrutiny, it is easier for them to be paying taxes somewhere rather than avoiding taxes altogether,” the Bahamas finance ministry official says.

Many tax havens also levy no tax on foreign corporations that earn their profits outside of the jurisdiction. By locating in a tax haven, a company – or an individual – can save heavily.

Apple lowered its corporate tax rate to 9.8 percent last year by utilizing tax havens, including the British Virgin Islands, according to an April New York Times investigation. The report suggested Apple legally avoided paying $2.4 billion in taxes.

Meanwhile, wealthy individuals were able to hide at least $21 trillion – and perhaps as much as $32 trillion – in offshore accounts as of 2010, according to a study released in July by the Tax Justice Network, an international organization that pushes for more transparency in international finance.

But governments are increasingly examining companies and individuals that utilize tax havens.

In the US, the Foreign Account Tax Compliance Act (FATCA), which the IRS says will help “improve tax compliance involving foreign financial assets and offshore accounts” takes effect next year. It will force US taxpayers to report their foreign assets to the IRS.

In London earlier this month, Google, Amazon, and Starbucks representatives were grilled in a Parliament hearing over accounting practices. Through accounting that booked sales in low-tax countries, like Ireland, the companies paid relatively little tax in the United Kingdom. Google, for example, booked sales of more than $4 billion in Britain but reportedly paid just a $10 million tax bill.

Margaret Hodge, a member of Parliament, pointedly said: “We are not accusing you of being illegal, We are accusing you of being immoral.”